European Options

European Options

European Options


Definition of a European Option:

European options are securities that give the owner the right to buy a stock or an index at a certain price at a certain date. Notice the phrase "at a certain date" as opposed to the American style ptions that can be exercised "by a certain date."

In other words, the difference between a European and American options is that the European style calls and puts can be exercised ONLY on the expiration date while the American style calls and puts can be exercised at any time PRIOR to their expiration date.

Most index options traded in the U.S. are European style. They also happen to be cash-settled since you can't actually buy 100 shares of an index.

What does this European option mean for the trader? It means that the you are concerned ONLY with the price of the stock or index at its expiration. European options tend to be cheaper than American style options because if a stock spikes prior to expiration, an American style trader can capitalize on that increase in value, whereas the European style trader has to hope the price spike holds until expiration.

european options chart

When to buy a European Style Calls and Puts

:

If you think a stock price is going to go up, then you should buy a European call option.

Example of a European Style Call:

If you bought a 100 shares of Apple Computer (AAPL) at $335 and you are afraid the price might drop below $300, you can buy an AAPL Put Option with a strike price of $300. That way if the price drops to $275 you will be able to exercise your option and sell your stock for $300. Please note that you don't "HAVE TO" sell your AAPL shares at $300! If the price in the market is $350 then of course you can sell your shares in the market at $350. That is why it is called an option--it is an option and not an obligation.

Important Tip: Even though these options are called 'European' or 'American' geography has absolutely nothing to do with the option. In other words, in the U.S. there are both European and American style calls ad puts. And in Europe, there are also both American and European calls and puts.

In the U.S., most equity and index calls and puts expire on the 3rd Friday of the month. Also, note that in the U.S. most contracts allow you to exercise your call or put at any time prior to the expiration date. In contrast, most European options only allow you to exercise the contract on the expiration date!

Options Trading

Options Resources and Links

Options trade on the Chicago Board of Options Exchange and the prices are reported by the Option Pricing Reporting Authority (OPRA):